One of the fundamental basics for all outsourcing relationships is the quality and flexibility of the commercial agreement between the customer and the supplier. A contract can be anything from a highly complex and weighty document to a to shorter ‘consumer’ style arrangement, but is crucial to all outsourcing relationships as it provides the legal framework between the organisations involved.

In addition to establishing a good contract (see below for discussion of what constitutes a ‘good’ contract) a key differentiator for success is the structure set up to manage the deal, as this establishes the approach for operating the contract, the interaction between the parties and ultimately the relationship between the organisations. It is not the length or complexity of the contract that is the key to a successful relation but the quality of the prior dialogue and resulting understanding of both parties that is embedded within it

There are many examples of the most stringent outsourcing contracts failing due to poor contract management. For example, a law firm who were described as having ‘trussed their supplier like a chicken’ through the contract, subsequently got through six programme managers in 18 months and the project fell two years behind schedule as no supplier staff wanted to work on the account. There are many other examples of healthy relationships based on less stringent contracts, such as a music industry client with a 100% flexible outsourcing contract. This was negotiated based on the supplier’s long history and experience, which demonstrated that the size of the deal would more than likely consume the resourcing flexibility it was committing to the account.

The Alsbridge definition of a ‘good’ outsourcing contract is one that is fair and sustainable between supplier and customer, and based on trust and partnership throughout the contracting process and beyond. A contract must stand the test of time; this means it continues to meet both parties’ expectations during the lifetime of the contract, not just at the start or at key milestones. The customer should receive the services and benefits they require, at the right time, while the supplier operates a profitable account and meets its own strategic objectives.

This paper defines the key principles for what constitutes a ‘good’ contract and deal management organisation in the current outsourcing landscape and addresses the key challenges for contracts in the future Cloud-based, on-demand IT and business services environment.

What makes a successful outsourcing contract?
The focus for success is clearly on the establishing the key principles for a high performing outsourcing relationship rather than the legal intricacies of the contract itself. There are fundamentals to a contract document which will include: scope, price, term, exit, liability, roles and responsibilities… the list goes on. The key point to take away is that it is not the contract which will break a deal; more often than not if the deal fails it is typically because the relationship between the customer and supplier has broken down. When both customer and supplier agree the principles for the deal and work together to meet a common set of expectations the contract should not gather dust, it is a key reference document and will evolve and continually reflect the business reality – what it needs is the mechanism to flex without creating administrative burden

Establish the business objectives. It is critical to establish the business objectives. This is primarily to understand whether the case for outsourcing will support the business strategy and to ensure there is sufficient business case for change. Delivery of the business objectives will ultimately measure the success of the programme and hence it is critical to have these defined and documented.

Develop the sourcing strategy. With the business objectives agreed the customer should develop the appropriate sourcing strategy to deliver the outcomes. The sourcing strategy will assess options including single or multi source agreements; will assess current and future delivery models; and agree a number of supplier selection criteria to ensure the best-fit supplier(s) are matched to the customer and business objectives.

Establish the right contracting process. A key step in any outsourcing deal is the contracting process. This will vary from deal to deal but typically revolves around an RFP-type document with a set of services for suppliers to bid for and a series of commercial discussions to agree the commercial model, pricing and legal liabilities.

Purely paper-based, arms length RFP procurement processes are dead. Private and public sector (driven by mature procurement legislation) recognise the real value of getting to learn about and understand the cultures of supplier and customer organisations. This comes from holding in-depth face-to-face discussions regarding the proposed scope and commercial models, and dialogue to test drive and pilot the proposed solutions. A collaborative, open and workshop-orientated approach enables both organisations to ultimately go into the deal with their eyes open and with full understanding of what is expected in order to deliver success. This is essentially the competitive dialogue in the public sector.

Too often organisations are driven to have an un-interactive approach where the contract is completed via the procurement process alone and the people who will run the deal on a day-to-day operational basis are brought on-board afterwards. This is too late; they should be involved from the start of the contracting process to ensure they are fully committed to, and accountable for, the outcomes.

Customers may use a ‘tried and tested’ internal approach or use a trusted 3rd party sourcing advisor to develop the right approach and behaviours. If customers don’t use an external advisor, it is valuable to establish a level of impartiality and independence into the deal team and to ensure objectivity and challenge remain, it is also useful to help overcome any deep-rooted mindsets which may be in place with key stakeholders.

To establish a fair and sustainable contract the customer should provide a number of commitments to the supplier:

to provide quality time to the suppliers and commit to take decisions promptly
to be open and honest about the current costs
to recognise the economics of the deal and expect a fair price
to be realistic about expectations of future improvements
and in return, the supplier should commit to:

promise only what can be delivered
provide a clear and complete picture of the services and pricing
involve delivery people early in the process and focus on the solution rather than the deal
align the economics of the deal and ensure a sustainable commercial model
recognise that the negotiation process takes time and will require give and take
An open and honest contracting process, involving customer and suppliers working in collaboration, should result in a deal that both parties can make work.

Ensure that expectations are aligned. Customers and suppliers should be crystal clear with each other from the outset about why they are entering the contract. When contracts fail often this is because expectations have not been managed from both sides and the objectives of the deal fail to be delivered. Managing expectations involved defining clear roles and responsibilities for all parties, but also related to the principles of the deal, it may be the difference between a purely cost-cutting focus to growth orientated services. Instances of misalignment also arise in situations where the customer wants innovation and transformation, yet the supplier is not incentivised for transformation and continues to deliver the core service as usual. In addition, financial engineering of the deal is an area where expectations often fail. Advisory firms like Alsbridge are often brought into distressed deals because customer circumstances changed part way through and the deal is felt to be no longer economically valid. Deal engineering (i.e. upfront cost savings, cash injections, paid for transition etc) ultimately needs to be paid for somewhere, and has to be factored into any commercial changes. It is similar to a mortgage deal in that if you buy a fixed rate and want to switch to variable rate within the notice period you will incur exit fees. The best contract is therefore one which has been firmly aligned to the customer’s business expectations over the short and medium terms, has predictable and transparent costs and can be flexible within reasonable change parameters or breakpoints.

Establish a deal management team. The customer and supplier should be in continuous communication to align operational and management teams in all areas of the deal. This is typically managed through a well performing deal management organisation but is also achieved informally through having a good-fit of organisational cultures between the customer and supplier firms.    

The deal management team will have segregation built in to ensure that the operational aspect of the service delivery and day-to-day supplier performance are not impacted by any ongoing contractual or commercial negotiations. Alsbridge are brought into many deals where the operations are impaired through contractual dispute, and service managers from customer and supplier sides are arguing the contract terms rather than focusing on their day-to-day roles. Clear roles and responsibilities are essential to a high performing outsourcing relationship.

The deal management team will actively manage project staff from the customer side and work together with the supplier to actively manage staff and contractor turnover. This is valuable throughout the life of a contract, as the most successful deals involve team members who were engaged in setting up the contract and therefore had a vested interest in ensuring its success. Contracts in distress will often be a result of team members brought on to the contract later in the deal lifecycle without knowledge of the deal principles. If anything, success is about communication, continuity of staff and the relationships that are built between customer and supplier as the contract develops. A high performing contract will involve continuous feedback and performance reporting loops between the parties to ensure both understand their requirements.

Cloud Sourcing contracts – It is not a case of if, but when. The commercial model and principles for contracting in today’s outsourcing market will suit suppliers and those customers buying ‘standard’ services. Yet standard services are less and less in demand as most corporates have done their greenfield outsourcing deals. The market for Cloud based business services is growing and customers are demanding much more flexibility in how services are provisioned and paid for.

The market for packaged software has peaked. Within 5 years we predict Cloud-based delivery of applications will account for half of this market (1 million businesses already using Google Apps). We believe that outsourcing of e-mail as a service will be routine within 2 years’ time. Alsbirdge’s Cloudsourcing survey (April 2009) highlighted that 65% of respondents are either already using or considering Virtual Infrastructure for applications. The commercial pressure and technical maturity have created robust infrastructure options offering a real alternative to standard infrastructure models. We predict rapid expansion and adoption over next 2 years.

The commercial logic of the Cloud is of major transformational journeys that require commitment from both the corporate-side and the supplier community to deliver. It is a case of adapt or die; those slowest to market will be left behind.

For the corporate customer there is a significant motivation to accelerate the process of transformation in the current recession, they require a low cost to change their businesses together with high expectations of benefits in terms of reduced operational costs and improved process flexibility. Yet suppliers have a significant motivation to resist and slow the transformation. Their long established margins are at risk and in the virtual Cloud-based world there are minimal barriers for customers switching suppliers at the ‘flick of a switch’.

In the short term, customers have much to gain at the expense of suppliers. Data centres with less than 10% average utilisation, unused licences, slow ramp up for new services and applications are areas of redundancy that customers are looking to remove from their organisations. Contracting for these services in the Cloud will become the new standard and will require a different set of contracting principles and a new basis for customer and supplier relationships.

Contracting in the Cloud
Given its business to consumer roots, current contracting practice places much emphasis on the supplier and potentially not enough on the corporate customer. Striking the optimum balance between ease of access and use and risk of service issues is important to get right.

With the potential benefits of highly automated services, comes the suppliers desire to automate and standardise the contracting processes in parallel (i.e. ‘click to accept’ terms and conditions, hence attempts to renegotiate key provisions may well be resisted.

As with contracting for traditional IT Outsourcing services, a detailed understanding of service provision and delivery is vital before entering into contractual commitments.

Typical areas for focus during negotiations include:

Service Level Agreements
Service Credits
Service Security
Service Business Continuity
Service Costing Formulae
Service Payment Provisions
Data Ownership & Protection
Legal & Regulatory Compliance
IP Protection & Reward
Software Licensing
Software Escrow
Choice of law and jurisdiction
Third party rights
Duration and termination rights
Change of control
TUPE

This is not designed to be an exhaustive list, but gives a flavour of the complexity and detail required to enter into a Cloud-based contract – “click to accept” is unlikely to be acceptable for most business situations. The difference with cloud is the commercial and business model within which it operates, the location of data, potential multi-tenancy agreements, on-demand hugely scalable and agile services (up and down); interoperability are all significant issues which impact the ‘consumer’ style models compared to enterprise wide solutions.

It is important to think about that transparency of cost and the impact of being able to allocate cost back to individual business units within an enterprise. This is key because that transparency brings accountability into the business user and puts the ‘brakes’ onto the demand model.

In the same way as when contracting for traditional IT Outsourcing services, a detailed understanding of service provision and delivery is vital before entering into contractual commitments.

The principles for contracting in the Cloud will have a step change on the outsourcing market and a significant level of work is being done to prepare the UK outsourcing market for the future of Cloud-based outsourcing services. Projects like the UK Government’s Secure G-Cloud have been established to design and implement cloud principles and services for whole of the UK Public Sector.

We already know that Cloud-based contracting will drive down the cost of software and infrastructure procurement and will allow much more transparent pricing as it will be on a pay by use basis. Other key areas of a typical outsourcing contract may also be radically changed. For instance, intellectual property will be shared across organisations and licensing will be pooled. For the UK public sector this will mean a single set of licences will exist and the entire public sector will be able to tap into the licence pool as required.

Cloud contracting offers easy switching between suppliers, at the end of the contract or specific service requirement i.e. after an IT project launch, customers may switch off or move to another supplier. Suppliers will consider contractual terms to restrict movement for instance maximum year length contracts, minimum termination clauses, open standards for connecting. It may seem that cloud is tipping the balance entirely toward the customer in this regard but customers have usually benefited from supplier investment into the deal, how suppliers are rewarded for investment and discourage rate shopping is an area that will require careful balance when going through a robust contracting phase.

In summary, many customers will continue to contract outsourcing deals as they have done in the past but the really successful organisations will work collaboratively with their partners to move toward cloud-based services integrated with other traditional ‘core’ infrastructure. The incumbent service provider has the advantage of knowing the customer organisation, the technical architecture and the quick win cloud services it could implement. The successful service providers will work with their customers to develop their cloud service offering and be able to develop their market.